Mutual-to-Stock Conversions: Tips for Investor

“Mutual-to-Stock” Conversions: Tips for Investors

Many banks and insurance companies in the U.S. are organized as “mutual
companies.” A mutual company is one that is owned — and sometimes governed — by its
members instead of being owned by public or private shareholders. In the case of a mutual savings bank
or a mutual savings association, the members are the financial institution’s depositors. In the
case of a mutual insurance company, the members are the insurance company’s policyholders.

Over the past two decades, a number of mutual companies have converted to a stock
form of ownership — either to raise money, to expand operations, to enhance employee benefit options,
or for some combination of these or other reasons. A host of federal and state banking laws
govern “mutual-to-stock” conversions of banks and savings associations, including the
rights — and responsibilities — of depositors. Similarly, state insurance laws govern
insurance company conversions.

This alert briefly describes how mutual-to-stock conversions work in the context
of banks and savings associations and provides tips for investors who participate in these transactions.

While some of the concepts described in this alert apply generally to insurance company conversions,
insurance regulation rests exclusively in the hands of the state governments. Always read the prospectus
for any conversion carefully, and contact
your state insurance
regulator if you have questions or concerns regarding an insurance company conversion.

How Bank and Savings Association Mutual-to-Stock Conversions Work

When a bank or savings association converts from mutual to stock form, the
financial institution (or its holding company) generally issues stock in
an initial public offering (or “IPO”).
Historically, individual investors have had a difficult time purchasing shares in IPOs — largely
because of the way those deals are structured and sold. With a bank or savings association mutual-to-stock
conversion, however, eligible depositors have a unique opportunity to participate and purchase shares
because federal and state banking regulations require that the bank or savings association give depositors
first priority to purchase the stock over all other interested investors. These priority subscription
rights allow depositors to purchase up to a set amount of shares at the “subscription price,”
which is the value the company assigns to its shares before the shares trade publicly. Stock offered as
a result of a conversion sometimes generates significant investor interest because of the potential for
the stock price to increase. If the IPO is over-subscribed — that is, if depositors and others who
have been given priority under federal and state banking regulations collectively sign up to purchase more
shares than the converting bank or savings association plans to offer — then the general public will
not have a chance to take part in the IPO.

To ensure that only depositors benefit from their priority stock subscription
rights, federal and state banking regulations prohibit depositors from transferring ownership of their
subscription rights — or of the stock itself — prior to completion of the conversion. These
restrictions on depositors — and any additional restrictions that the financial institution
imposes — will always appear in the prospectus for the conversion. In addition, converting banks
and savings associations typically require depositors to sign a “subscription agreement”
or “stock order form” that contains written certification (signed under penalty of perjury)
that the depositor is purchasing the conversion stock for his or her “own account” and that
he or she has “no agreement or understanding regarding the sale or transfer of” any shares he
or she receives.

But, as several SEC enforcement actions in this area confirm, opportunists
(or “fraudsters”) periodically attempt to circumvent these laws and participate illegally
in mutual bank or savings association conversions. Links to these enforcement actions are included at
the end of this alert.

How Fraudsters Take Advantage

The rare ability for ordinary individuals to get in on the ground floor of an IPO
makes mutual-to-stock conversions ripe for abuse. Although there are many variations of this type of
scheme, in the typical case, the fraudster will identify and approach a depositor who has non-transferable
subscription rights, offering to “loan” the depositor the money required to purchase the
maximum number of shares. Converting financial institutions typically require depositors to pay up front
and in full for the shares they request at the time they submit their subscription agreements or stock
order forms. Those sums can easily be tens or hundreds of thousands of dollars — amounts that
many depositors cannot afford on their own.

In exchange for funding the purchase, the fraudster typically will require the
depositor to either (1) transfer the conversion stock to an account that the fraudster controls or (2)
sell the stock and give the fraudster a majority of the profits. The fraudster will further persuade
the depositor to keep secret their arrangement and to submit subscription documents or stock order forms
that falsely (or misleadingly) represent to the bank or savings association that the depositor is the
true purchaser of the stock, has not transferred his or her subscription rights to any person or entity,
and has entered into no agreement regarding the sale or transfer of the stock. After the conversion
occurs, the fraudster typically will determine when to sell the stock (but sometimes lets the depositor
decide when to sell) and will split any profits with the depositor. In most cases, the fraudster gets
well over half the profits, and frequently the fraudster gets over 75% of the profits.

Mutual depositors who enter into agreements with such fraudsters should be aware
that these fraudsters may be violating not only state and federal banking laws, but also the antifraud
provisions of the federal securities laws and various federal criminal laws. Moroever, mutual depositors
should be aware that, by entering into such agreements, they may be violating these laws themselves and
may be subject to civil enforcement actions or criminal prosecution. In fact, in the last few years several individuals have faced both civil enforcement actions and criminal prosecution in connection with such agreements.

What Investors Need to Know

Key concepts for investors to bear in mind when considering whether to participate
in a mutual bank conversion include the following:

Know the Rules — By law, depositors cannot sell or transfer their priority
subscription rights, or the stock itself, prior to the completion of a financial institution’s
conversion. Moreover, depositors cannot enter into agreements or arrangements to sell or transfer
either their subscription rights or the underlying conversion stock.

Read the Prospectus and Stock Order Forms Carefully — These
documents may contain broader, more explicit restrictions than the threshold set by applicable state
and federal banking laws. Typically, prospectuses prohibit any agreements regarding the sale
or transfer of the stock. Financial institutions have the right to reject any stock order forms that
do not comply with either the letter of the law or the wording of the prospectus.

“Neither a Borrower nor a Lender Be” —
Shakespeare’s words ring especially true in the context of mutual bank conversions. If someone
offers to lend you money so that you can participate — or participate more fully — in
the conversion, be extremely wary. Be even more wary if the source of the money is someone you do
not know. The loan agreement may make you unable to certify truthfully that you are the true holder
of the subscription rights and the true purchaser of the stock and that you have no agreements
regarding the sale or transfer of the stock.

Watch Out for Opportunists — The opportunist may tell you that
he or she is a lawyer — or a consultant or a professional investor or some similarly impressive
tale — who has experience with similar mutual bank conversion transactions. The opportunist
may even approach you through one of your friends or family members. But if the people proposing a
deal stand to profit from it, take their words and promises with a grain (or perhaps a pound) of salt.
Fraudsters rarely act in the “best interests” of anyone but themselves.

Be Wary of Guarantees — Some fraudsters will go to extreme
lengths to assure you that the arrangement you’re entering into is perfectly legitimate. They
might tell you that they’ve done scores of these transactions and that this is simply how they work. Or they might downplay the warnings or restrictions in the prospectus or order form, telling you that “everyone” enters into such agreements or that the deal they’re offering is legitimate. They may also tell you that you have no risk in the transaction. The cold, hard truth is that fraudsters lie.

Get the Facts from the Source — If you have any questions about a
mutual conversion transaction, ask the bank or savings association for more information. If you have
any doubts about a transaction proposed to you by someone else, ask the bank or savings association
whether the proposed arrangement is proper. You may be able to find helpful resources on the
institution’s website or by visiting a branch office.

The bottom line for investors is always to remember that if an opportunity sounds too good to be
true, it probably is too good to be true.

If you are eligible to purchase stock in a mutual bank or savings association
conversion, and someone proposes some sort of “mutually beneficial arrangement” involving
your subscription rights or the stock itself, please file a detailed complaint with the SEC using our
online Complaint Center. Be sure to include the name
of the bank or savings association and provide any contact information for each individual involved. You
should also send your information to the appropriate state and federal banking authorities.

For more information about investing wisely, please visit
the Investor Information section of
the SEC’s website.

* * * *

SEC Enforcement Actions

Here are some pending or past SEC enforcement actions brought against individuals in
connection with mutual bank conversions (with links to litigation releases posted on the
SEC’s website):